"Iceland has from the start maintained that there is legal uncertainty as to whether a state is responsible for ensuring payments of minimum guarantees to depositors using its own funds and has stressed the importance of having this issue clarified in court," it said.

When Icesave, an online savings bank, went bust in the autumn of 2008 at the height of the international banking crisis, the UK government stepped in.

To maintain public confidence and prevent a run on any other banks, the then UK Chancellor Alistair Darling decided to bail out 230,000 UK savers in Icesave to the full extent of their savings - about £3.5bn - not just to the minimum decreed by European rules for deposit compensation schemes.

At the time, the Icelandic scheme was responsible for the first 20,887 euros (£16,300) of compensation, with that being topped up to then ceiling of £50,000 per person by the UK Financial Services Compensation Scheme (FSCS).

Analysis

By Simon GompertzPersonal finance correspondent, BBC News

A ruling from the little known EFTA court has put a fundamental objective of European idealists in doubt; that banks should be able to offer savings accounts to customers across Europe and that customers, in turn, should be confident that their deposits will be protected.

The court says that Iceland did not have to compensate Icesave customers in the UK because the relevant European directive did not oblige the government to set a minimum amount for compensation, nor did it force the state to pick up the tab if banks themselves could not pay.

That is a big worry and a disappointment for the UK. But it may not be a reason to panic over future failures of foreign banks with British customers.

All this happened at the height of the financial crisis in 2008. Since then, the European directive on deposit guarantee schemes has been amended, so that it now lays down that the state shall ensure that the guarantee is set at a minimum level of 100,000 euros for each saver.

However, there is still an element of doubt over how robust this guarantee would be if a country as small as Iceland was engulfed by another major crisis.

The EFTA judgement stated: "The Court holds that the Directive does not envisage that the defendant itself must ensure payments to depositors in the Icesave branches in the Netherlands and the United Kingdom, in accordance with Articles 7 and 10 of the Directive, in a systemic crisis of the magnitude experienced in Iceland."

The Icelandic government said the failed Landsbanki had in fact already paid out 90% of the maximum compensation it should have paid under the European rules, and would continue with more repayments.

Icelandic saga

Since 2008, the UK government has been thwarted in its attempts to force the Icelandic government to repay all of the compensation the UK had paid to its citizens who had money in Icesave.

At first, in 2009, the Icelandic government agreed to repay the compensation given by the UK and Dutch governments.

However most of the Icelandic people were bitterly opposed to the suggested deal, fearing that it would bankrupt their country and was, in any case, fundamentally unfair because the UK and Dutch governments had awarded compensation far in excess of the levels required by European legislation.

A full-scale constitutional and diplomatic crisis ensued when the country's president refused to ratify the deal and instead called a referendum, which overwhelmingly rejected the deal in March 2010.

A second deal struck between the three governments was followed by a second referendum in April 2011 but this also rejected proposed repayments, though by the much narrower margin of 59% to 41%.

The UK and Dutch governments then threatened to sue for the money - a move which now appears to have hit the buffers.